Protect Yourself When Taking the R&D Credit

The federal tax laws require business owners claiming the
R&D credit to discover information that is "technological
in nature," a so-called discovery test. The definition of the
test is likely to be modified, but for now, many companies find it
undefined and confusing.

The credit is designed to encourage businesses to increase their
spending in R&D. While the credit is not permanent, Congress
has continually extended it. The Tax Extension and Relief Act
extended the credit through mid-2004. Unlike a deduction, which
reduces taxable income, a credit is a dollar-for-dollar reduction
in your tax bill.

Until the regulations are finalized, Mark Andrus, national
director for Grant Thornton's R&D services, recommends that
companies using the credit be ready for the possibility of an
audit. Here's how to protect yourself:

During the development project--or in the initial planning
stages--be sure to document what you didn't know and what
information you intend to discover.

Document the development process. Keep laboratory and meeting
notes or reports that outline steps taken to discover new
information or to apply new information to the development of a new
product or process.

Use a tax expert to help with the documentation. The credit can
help defer the cost of innovation, but the rules are complex and
fluid.

While the IRS will probably continue to challenge companies on
the test, Andrus says, "businesses can continue to claim the
R&D credit, but to maximize the opportunity, follow the
recommendations above."